Spin-offs are very well known and followed special situations. Spin-offs are segments or business units of companies that become independent businesses with assets and employees taken from the parent company. In a spin-off of a public company, shareholders of the parent company receive equivalent shares in the new company (which is part of the parent company). Shareholders may then buy and sell stocks from either company independently on the market.

There are many interesting aspects of a spin-off as these transactions potentially makes investment in the companies (both the parent and/or the new formed company) more attractive. The new company might e.g. have new management, an improved balance sheet, more focus, and much more. Now that the business segment is on its own, the market might value the segment better than it used to as part the parent company. In addition, the spin-off might be attractively priced. In addition, the parent generally retains a stake in the spun-out company. This means that if the spun-out company performs well, it might be reflected in the parent’s valuation as well.

A lot had been written over the years, but they still remain very compelling opportunities. Example. Hexagon Composites (HEX, Norway) very recently spun-off subsidiary Hexagon Purus (HPUR, Norway). I’m not going into the details of both companies’ operations – I will just describe the opportunity.

HPUR operates in a very ‘hot’ market (fuel cell and battery electric vehicle products and infrastructure). Needless to say that companies in this industry are valued very richly at the moment. In addition to very interesting end-markets, HPUR also listed on an exchange where multiples for these kind of companies are through the roof at the moment. I’m not saying these multiples are reasonable (actually often they don’t make sense). There is clearly a lot of promise for future growth, but this growth is generally more than priced in. Nonetheless, one could have traded the rerating of HPUR’s multiple to the industry multiple. Indeed, HPUR listed mid-December at ~30 NOK per share and has almost tripled since.

But the trade is not over. HEX (the parent company) still owns ~75% of HPUR. This is at the moment basically the entire market cap of HEX, while HPUR only constituted ~12% of HEX’s revenues. At the moment, one can buy HPUR exposure at a discount by just buying HEX (or buy HPUR via HEX and receive the rest of HEX’s business for free).

Now, going long HEX might be a good trade, though one is exposed to the volatility of the hype in HPUR’s industry. Yes, HPUR operates in a very promising and fast growing industry and revenues are expected to grow 70%-90% p.a. for the foreseeable future, but I doubt they will make any profit (let alone cash flow) over the next 5 years. The industry might suffer big corrections (and I expect they will). A better trade might be to play the narrowing of the spread, i.c. the differential between HPUR’s valuation and the (implied) value of HEX’s stake in HPUR. This basically means going long HEX shares and short HPUR shares, where the trade is that the market will start to properly reflect the value of HPUR’s stake in HEX’s share price and the gap will close. This trade makes in my opinion for a much more attractive risk/reward. Word of caution, do not initiate these kind of trades if you do not understand the mechanics and risk exposures of the trade.

The latest Hexagon presentation.